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India gearing for Advance Pricing Agreements

The concept of ‘One World – One Economy’ is developing very fast, and cross border trades
are growing leaps and bounds. More than 60 percent of the world trade takes place within
Multinational Enterprises. The astonishing growth in the intra-group international transactions is
visualizing serious transfer pricing issues. The complexity of transfer pricing seems to be
growing as businesses continuously restructure operations around the globe to remain
competitive and tax authorities struggle to prevent tax base erosion.

Transfer pricing issues present many challenges such as detailed scrutiny by transfer pricing
authorities worldwide, robust documentation requirements, imprecise rules leading to costly,
time-consuming and disruptive defense of transfer pricing policies and methodologies,
increasing litigations. All these result in economic double taxation. The only solution to these
problems is the advance pricing agreements (‘APA’).

Organization for Economic Co-operation and Development (‘OECD’) defines APA as an


arrangement that determines, in advance of controlled transactions, an appropriate set of criteria
for the determination of the transfer pricing for those transactions over a fixed period of time.

An APA is an arrangement between the taxpayer and the taxing authority under which the two
parties agree on the transfer pricing policy for specified transactions of the taxpayer over a
given period of time. Such a ruling would be binding on the taxpayer and the tax authorities.

Most countries allow for APAs under their transfer pricing regulations as they help prevent
actual or potential pricing disputes in a co-operative manner. They also provide an alternative to
traditional dispute resolution. APAs provide much-needed certainty that foreign companies look
for while making investment decision. An APA mechanism provides taxpayers with an avenue
to proactively defend their transfer pricing policies rather than doing so reactively under
assessment.

Industry and tax experts in India have demanded APAs be put in place ever since transfer
pricing laws were introduced in the country in 2001. India being a service hub it was essential to
introducing APA mechanisms to provide greater certainty. Accordingly, to harmonise the
transfer pricing regulations with international best practices and with a view to provide certainty
to taxpayers in respect of their tax liability arising from any future international transaction, the
Government of India finally decided to introduce the APA.

Direct Tax Code (‘DTC’) proposed to come into effect from 1 April 2010 empowers the Central
Board of Direct Taxes to formulate a scheme to enable it to enter into, with the approval of the
Central Government, advance pricing agreements with taxpayers in relation to the proposed
international transactions.

APAs can be unilateral, bilateral or multilateral.


Unilateral APA involves tax authorities of one country. In this case, the two parties negotiate an
appropriate transfer pricing policy for tax purposes of that country only. If the taxpayer faces
any dispute with foreign tax administration regarding the transaction covered under APA, he
may need to seek relief by requesting that the Competent Authority and initiate a mutual
agreement proceeding provided there is an applicable income tax treaty in force with that
foreign country.

Bilateral APA or Multilateral APA involves tax authorities of two or more than two countries
under the authority of the mutual agreement procedure specified in income tax treaties. The
taxpayer benefits from such agreements since it is assured that income associated with the
transaction under APA is not subject to double taxation by the home country and the relevant
foreign tax authorities. Bilateral APA or Multilateral APA also decreases the incidence of
economic double taxation. As per OECD recommendations, wherever possible an APA should
be concluded on a bilateral or multilateral basis between CAs through the Mutual Agreement
Procedure of the relevant treaty. Whenever unilateral APAs are permitted, the CAs of other
interested jurisdictions should be informed about the procedure as early as possible, so as to
determine whether they are willing to consider a bilateral arrangement under MAP.

In the Indian context, pending framing of the Scheme, prima facie it appears that the Direct
Taxes Code provides for a unilateral APA mechanism. It would be important that for the APA
programme to succeed it should contain a provision for bilateral/multilateral APA mechanism.
The arrangement would be valid for a specified period subject to a maximum of five financial
years and would continue to be valid during the said period, on the basis that the facts and
conditions, based on which the rulings have been passed have not undergone a change.

The Direct Taxes Code provides that the Board would frame a scheme for the functioning of the
APA programme. Typically there are five steps to reach an APA. The steps involved are:

Application and Pre-Filing Conference: The taxpayer can request a pre-filing conference,
which can be on either an anonymous or identified basis. The purpose is to discuss the proposed
APA with the APA programme personnel before committing to the process;

Due Diligence - APA Team must satisfy itself that the taxpayer’s submitted facts are complete
and accurate. Economists perform a significant part of the analytical work for an APA. This
analysis may result in the need for additional information from the taxpayer.

Evaluation and analysis: By the tax authority of the reasonableness of the taxpayer’s proposed
APA, followed by:

Negotiation: Tax authority negotiates with the taxpayer on any modifications or changes to the
original APA submission;
Discussion and Agreement: Bilateral APA goes through a Competent Authority (CA) process
where the CA analyst opens negotiations with the foreign CA and drafts the so-called mutual
agreement letter; and

Drafting, Review & Execution: Once all parties to an APA are in agreement, drafting the final
document takes little time as standard language is often used. Once drafted the APA director
and the taxpayer would execute the APA.

An APA program cannot be used by all taxpayers because the procedure can be expensive and
time-consuming and small taxpayers generally may not be able to afford it. This is especially
true if independent experts are involved. APAs may therefore only assist in resolving mainly
large transfer pricing cases.

Some of the advantages of APAs are that they are cost-effective means to resolve transfer
pricing issues because they are less adversarial than is typically the case under transfer pricing
audits. APAs prevent unnecessary and protracted litigation that are going on over transfer
pricing. APAs offer better assurance on the transfer pricing method accepts. As an effect, they
ease the possibility of risk and assist the financial reporting of possible tax liabilities. Enables
MNCs to plan their TP strategies, including methodology to be used with more certainty. APAs
also decrease the incidence of double taxation and costs linked with audit defense and TP
documentation preparation. Places taxpayers in a better position to presents their case/enable
taxpayers to build rapport with revenue authorities. According to OECD guidelines an APA can
provide opportunity to apply agreed TPM to resolve similar TP issues in open prior years.

Some of the key challenges before the Indian tax department while applying APA mechanism in
can be as discussed under:

• The feasibility of an APA mechanism under the Indian conditions.


• Clearly defined goals and responsibilities for the APA programme, including a strong legal
framework incorporating the APA mechanism into domestic tax law.
• Dedicated APA team, separate from examiners: A dedicated APA team that negotiates
APAs as well as reviews the APA documentation submitted by the taxpayer will ensure
consistency in the interpretation of the critical assumptions of the APA, and thus enhance
effectiveness.
• Availability of specialist resources with industry knowledge for the APA team along with
requisite database.
• Formulate the mechanism which provides simplicity in APA process and open negotiation;
• Formulate position on rollbacks: the taxpayer must have assurance that the past closed years
will not be reopened for audit based on the transfer pricing agreed in the APA.